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Emerging Markets:
Crossing the Rubicon.
DECEMBER 2012
The surging growth of many emerging markets is
changing the structure of the global economy. The
trend is accelerating such that the term ‘emerging’
will increasingly cease to apply to many countries
and a shift in categorization will be required.
In such a rapidly changing investment environment,
investors must make the best tactical decisions to
take advantage of the opportunities. One key to this
for index-based investment products is choosing
well-constructed indexes that track macro trends in
emerging markets (EMs) with greater accuracy,
resulting in more sophisticated and potentially
profitable investment allocations.
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Emerging Markets: Crossing the Rubicon
A powerful combination of macro trends – each of them a
possible investment theme – is driving the long term rise of
EMs. These include the emergence of a vast new middle class,
mainly in Asia, of around 4 billion people by 2030; rapid
urbanization; the gradual move by many EMs from export-led
to consumption-led growth; and an emphasis on the
production of higher value-added products. Over the last
decade emerging economies have seen a dramatic decline
in net external debt with public debt as a percentage of GDP
substantially lower than that of developed economies. Indeed,
since the late 1990s, emerging economies have moved from
net debtor to net creditor status. China is at the forefront of
these changes. Over the last 10 years China has soared from
sixth to the second largest economy in the world; its foreign
exchange reserves have increased from $250bn to $3.3 trillion.
Yet the significant macro trend for investors may have been
the decoupling of growth rates in emerging and developed
economies. Until about 2000, such growth rates were
reasonably comparable, which made the case for investing in
EMs quite difficult to make. Since then, EM growth has moved
to a consistently higher level and now stands at 6.2% compared
with only 2.6% in advanced economies according to IMF
projections. And, while the advanced economies struggle
under the burdens of recession and financial crisis, EMs have
become the dominant drivers of global growth. In other words,
EMs appear to have crossed a structural Rubicon.
“EM growth has moved to
a consistently higher level
and now stands at 6.2%
compared with only 2.6%
in advanced economies.”
Decoupling in growth rates
Source: IMF
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Emerging Markets: Crossing the Rubicon
As investors formulate their own view of the future implications
of these growth trend rates, faster EM growth likely means
these economies will increasingly comprise a larger share of the
global economy. For example, the OECD projects that China’s
share of global GDP will soar from 17% in 2012 to 28% in 2030,
and India’s from 7% to 11%; whereas the US share will fall from
23% to 18%, and the Euro area from 17% to 12%. Such rapid
growth will inevitably have a dramatic effect on the wealth of
people living in emerging economies. Just as Japan experienced
a dramatic increase in GDP per capita from about 1955 to
1985, EMs are likely to follow a similar trajectory. On this basis,
China may see GDP per capita of around $50,000 by 2030,
compared with less than $4,000 in 2009, and other EMs may
follow the same path.
This raises the question of how should emerging countries
be categorized as they achieve levels of individual wealth
comparable to that of developed economies? The World
Bank’s system of classification by gross national income per
capita (GNI) puts any country with GNI above about $12,500
in the ‘high income’ category. South Korea and Taiwan achieved
this some time ago and, from the projections above, it appears
that China and others will soon follow. As they do so, traditional
distinctions between emerging and developed markets will
start to look anachronistic and irrelevant. We may have to start
talking simply about ‘low growth / high income’ countries
versus ‘high growth / high income countries’.
The impact of compound arithmetic on GDP/capita:
Developed/Emerging to become an anachronism?
GDP / Capita
2009 ($)
2030 ($)
Asia – ex Japan
7,667
88,450
China
3,704
50,235
India
1,033
20,406
44,871
103,246
United States
Source: Standard and Chartered Bank 2010
World Bank Country Classification
2011, GNI per capita ($)
Low income
1,025 or less
Lower middle income
1,026 - 4,035
Upper middle income
4,036 - 12,475
High income
12,476+
Source: World Bank
In addition the potentially significant shift in GDP share
(using OECD forecasts) poses questions as to how this will
be reflected in the future geographical breakdown of global
equity indexes. The US equity market currently constitutes
about 45% of the FTSE All World Index and this is roughly twice
the US share of global GDP of 23%. If the OECD projection is
correct and the US share of GDP declines to 18% by 2030,
how will this be reflected in the representation of the US in
global equity market indexes? The repercussions of a decline
in developed country and US weightings in global equity
indexes raise the question of which regions will be the
beneficiaries of any reallocation.
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Emerging Markets: Crossing the Rubicon
“At the heart of the FTSE
process is a governance
structure consisting of
specialized external
committees of market
professionals and
practitioners.”
Indexes constructed with macro trends in mind can serve as
key tools enabling investors to formulate their strategic and
tactical approaches. However, in selecting an index, it is
important to be aware that they are not all created equal –
different indexes reflect different criteria. It is critical to
understand these differences as they potentially have a
significant impact on an index’s composition.
FTSE has been calculating international indexes since the
1980s using a transparent rule-based process. It publishes
its methodology in detail such that its indexes are predictable
and reflect the consensus among its users who are themselves
industry practitioners. At the heart of the FTSE process is a
governance structure consisting of specialized external
committees of such market professionals. The in-depth
knowledge of the committee members feeds into the way the
indices are managed and allows a structured approach to
dealing with market changes and macro trends like those
discussed above.
Index Governance
FTSE Policy Group
FTSE Regional Equity
Committees
FTSE Nationality
Committee
FTSE EMEA Regional Committee
FTSE Americas Regional Committee
FTSE Asia Pacific Regional Committee
FTSE Country
Classification
Committee
FTSE Bond Indexes
Committee
FTSE ICB Advisory
Committee
• T he committees ensure that the
indexes are managed and calculated
according to transparent index rules
• T he committees ensure that the
indexes continue to meet market
needs and advise on the design and
creation of new indexes
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Emerging Markets: Crossing the Rubicon
This governance system gives FTSE’s indexes some unique
characteristics. Firstly, FTSE covers a large universe of large
and mid-cap stocks, taking account of more than 90% of all
companies globally. It does not omit a stock simply because it
is difficult to identify where it belongs and has detailed rules to
classify and include all stocks. With fewer missed companies, or
‘orphans’, its indexes provide a ‘true’ opportunity set for investors.
It screens stocks for liquidity and free-float (the number of
shares actually available for investors to buy). Indeed, FTSE
was one of the first index providers to introduce the principle
of free float adjustments which has now become the industry
standard. (From March 2013, FTSE will move to actual free float,
calculating the free float to within one percent accuracy).
Another key difference in FTSE’s EM indexes, stemming from its
transparent market-driven approach, is the country classification
system. Although GNI is important, FTSE considers a range of
other indicators relating to the quality of the dealing landscape
(including derivatives market), custody and settlement, and the
market and regulatory environment. This allows FTSE to make
informed decisions when reviewing a country’s classification
status. An example of this approach is that South Korea was
placed on FTSE’s watch list for three years before its elevation
to Developed market status. South Korea was added to FTSE’s
Developed market indexes in September 2009.
Equipped with these indexes, investors can begin to make
informed tactical decisions about EMs. A comparison of
FTSE’s Emerging and Developed indexes shows EMs have
significantly outperformed developed markets in aggregate
over the last decade.
As the macro trends sweeping through EMs shake the world
economy, investors will need to respond in a rigorously
strategic fashion. However, as with any major economic shift,
there is a substantial amount of background ‘noise’ to distract
and divert attention. FTSE’s indexes are an invaluable aid to
the task of cutting through the noise and identifying where
and how the underlying value may be found.
Correlation FTSE Emerging vs FTSE Developed Total return (USD)
Source: FTSE
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Emerging Markets: Crossing the Rubicon
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